1 doing business in Canada 1 real estate and urban development Real estate is a broad category that covers buying, selling, developing, leasing and financing across a wide range of sectors from mining, forestry, and oil and gas to light-to-heavy industrial, commercial, residential, recreational, retail, office, condominiums, subdivisions, urban development, brownfields and mixeduse development. As a result, Canada attracts investors, businesses and individuals from far and wide seeking to invest in its varied real estate assets.
2 2 doing business in Canada 1. Foreign investment There are several legal structures available for investment in Canadian real estate. Understanding the principal issues involved in acquiring, developing, leasing and/or financing property in Canada is critical to assisting a foreign investor in properly assessing the risks and rewards associated with any proposed investment. The provinces have primary responsibility for property law in Canada. In all provinces except Québec, property law has developed through the English common law process. In Québec, property law is governed by the Civil Code of Québec, which is derived from the Napoleonic Code. There is no constitutional protection for property rights in Canada. Consequently, property can be expropriated by government and quasi-governmental authorities but, appropriate compensation must be paid by the expropriating party. All contracts and agreements dealing with real estate should contemplate the potential risks and consequences of either part or all of the lands being expropriated. Interests in land are generally held directly in fee simple or by leases as leasehold interests. Condominium or strata title ownership is also common throughout Canada. All provinces maintain a system of public land titles registration whereby ownership can be verified and through which interests in land are registered. Canada has highly sophisticated land registration systems in place in each province and territory to deal with the ownership of real property. 2. Investment vehicles There are several legal structures available for investment in Canadian real estate, including: A corporation (either federally or provincially incorporated) General partnership Limited partnership Co-ownership (often referred to as a joint venture ) Trust Real estate investment trust Personal ownership Or any combination of the above The choice of an appropriate investment structure will be governed by factors such as tax planning requirements, liability issues and business considerations, as well as each foreign investor s rules and regulations. It is critical to seek tax planning advice before purchasing real property in Canada to minimize tax consequences and maximize tax benefits available in the country. a. Real estate investment trusts (REITs) A REIT is a trust established to consolidate the capital of a large number of investors for the purpose of investment in real estate, often through the direct acquisition of income-producing real estate assets. In addition to investing in income-producing properties, REITs may also buy, develop, manage and sell a wide variety of real estate assets. Investors in the trust are usually issued units, which represent an undivided beneficial interest in the trust, and are then allocated a pro rata share of the income and losses of the trust. The REIT structure has grown in popularity over the past decade, as REITs provide a number of advantages to both real estate companies and REIT unit holders. These include favourable tax treatment and improved tax efficiency on distributions to unit holders, improved access to equity markets for real estate companies, and a generally stable stream of income with the potential for high-yield capital growth for real estate investors. b. Joint venture structures Commercial real estate properties may also be held through a joint venture structure. A joint venture is a relationship between two or more entities that have invested their assets or carry on business together in order to realize a profit. There are several alternative joint venture structures, with the most common being joint venture corporations, partnerships, co-ownerships and co-tenancies. Joint venture corporations are generally structured so that each party holds shares in the corporation and enters into a shareholders agreement to govern the corporate relationship. Joint
3 doing business in Canada 3 venture corporations enjoy many of the same advantages as corporations in general, including limited liability, ease of administration, and a certainty of legal rights and obligations. A joint venture may also hold property in either a general or a limited partnership. A partnership agreement will typically be used to govern the relationship between the persons carrying on the business, and to allocate profits and losses between the parties. One of the primary advantages of the partnership structure is its flexibility, because it allows for varied and other non-proportionate sharing of the profits and losses. A tenancy in common or undivided co-ownership which is a relationship between two or more parties with a direct or indirect ownership interest in property is also common. Each co-tenant or co-owner has an undivided interest that provides an equal right to use and possession. Co-tenants or co-owners will typically enter into a co-ownership agreement that governs this relationship and the ability of each party to deal with its interest. Co-tenants bear no responsibility for the debts of other co-tenants or co-owners, and have no right to act as agent for any other co-tenant or co-owner. Each co-tenant or co-owner is considered its own entity, and thus each co-tenant is entitled to sell or finance its interest in the joint venture property. We have certainly seen many situations in which joint venture arrangements between parties were not structured properly, which have resulted in serious disputes between the parties. Joint venture agreements should be vetted by counsel to ensure that not only the basic business terms are incorporated into them, but that consideration is also given to practical business, operational, management and termination issues. 3. Acquisitions and dispositions a. Acquisitions To acquire real estate in Canada, parties typically enter into one of the following: A letter of intent An offer to purchase An agreement of purchase and sale Notwithstanding what the parties call their document, this agreement should contain all necessary business terms for the transaction, including (without limitation), the description of the land, purchase price, deposit(s), closing date, title and/or due diligence periods, representations and warranties, and any other special terms and conditions that the parties agree to. Some provinces and jurisdictions have real estate boards that dictate the form that is typically used, but parties are generally permitted to use their own form if they decide not to use the local real estate board s prescribed form. It is always advisable to have a lawyer review any preliminary deal document, such as an offer or agreement of purchase and sale, before it is signed. When purchasing, it is important to seek advice in connection with the various federal, provincial and, sometimes, municipal taxes that may be exigible in connection with a particular transaction, such as land transfer tax, withholding tax for foreign investors, harmonized and provincial sales tax, capital gains tax, developmental and educational charges and taxes, and the list goes on. It is also always best to have local people involved in your real estate transactions, whether you are buying or selling. b. Dispositions Whether you are buying or selling, it is always important to put all of the critical business terms in the letter of intent or agreement of purchase and sale. Certain cities within Canada have established real estate boards that provide standard form agreements of purchase and sale, as well as other precedent agreements. While using these types of precedent agreements is advisable, for more sophisticated acquisitions and dispositions, it is wise to consider longer form agreements that address many more issues. Examples include the allocation of the purchase price among the real property, building and chattels (if any), conditions precedent for either or both of the buyer and the seller, HST exemption status of the real estate and/or the buyer, scope of representations and warranties, scope and/or limitations on due diligence and deliveries, etc.
4 4 doing business in Canada 4. Due diligence Once the agreement of purchase and sale is signed, it is generally the responsibility of the purchaser (usually through counsel) to conduct due diligence concerning the property being acquired. This includes title to the real estate and any personal property assets being acquired as part of the agreement of purchase and sale, assorted off-title enquiries, road access, adjoining lands searches, zoning compliance, utilities, conservation authority, environmental investigations, heritage designations, registered and unregistered easements, municipal agreements, airport zoning bylaws, and survey and lease reviews. In addition, when purchasing a building or structure, it is also recommended to conduct structural, mechanical, electrical and plumbing investigations. 5. Title insurance While title insurance is a recent phenomenon in Canada, it is available right across the country. In fact, certain provinces, such as Ontario, require lawyers to inform residential purchasers that they can either rely on (i) a solicitor s opinion, (ii) title insurance offered by the Law Society of Upper Canada title insurer or (iii) a third-party title insurance provider. Due to what tends to be more sophisticated and complex title registration systems across the country, title insurance may not be the best option for every transaction. One of the selling features of title insurance in Canada is the cost savings on due diligence searches, but this is only relevant up to a certain point. 6. Land-use planning A number of provinces in Canada have implemented land-use planning legislation, bylaws and regulations to control the manner in which real estate is developed. Land-use planning is the responsibility of the provincial government and is supervised at the provincial level, but significant planning functions have been delegated to the various regional governments and municipalities. Land use is controlled through instruments such as the official plan (a long-range general plan for a region or
5 doing business in Canada 5 municipality) and zoning bylaws (which regulate, for each parcel of land in the municipality, the uses permitted and other matters, such as required parking and the type, size, height, and location of building and structure). For a purchaser of land, both the official plan and particular zoning bylaws are crucial. Most municipalities require that site plans be approved before the construction of any new development. Site plans set out the details of a development including the location of buildings and related facilities, such as landscaping, services, driveways and parking spaces. Most municipalities require the developer to enter into an agreement ensuring construction and ongoing maintenance in accordance with the site plans. Land-use planning legislation not only affects the subdivision and transfer of land, but it also often applies to long-term leases and rights that are given over or in connection with land. In Ontario for example, any subdivision of land requires the consent of the local committee of adjustment or subdivision control committee pursuant to the Planning Act (Ontario). This requirement also applies to a mortgage or the granting of any other interest in land such as a lease for 21 years or more (inclusive of renewals) where the mortgage or interest is granted over only part of a landholding. The failure to obtain such consent when otherwise required will result in the failure of the deed, mortgage or lease to create any interest in the real property. Although there are a number of exemptions to the requirement for consent, most contracts for the purchase of real property in Ontario are made subject to any required consent, and the cost and responsibility for obtaining such consent is usually allocated to the vendor. Anyone wishing to subdivide land in Ontario, or to subdivide and sell lots, must obtain governmental consent and may be required to submit a draft plan of subdivision for approval. Normally, the municipality will require the developer to enter into development agreements whereby the developer agrees to provide sewers, roads and other services for the subdivision, the dedication of certain lands for public use and certain other public benefits. In Québec, an Act respecting land use planning and development gives to each municipality the responsibility for the administration of its territory for municipal purposes. 7. Leasing Leasing is a highly complex area. There are several ways to lease property in Canada. a. Ground leases Property may be leased as well as purchased. One form of leasing arrangement is a long-term ground lease, in which a tenant leases vacant land and develops it. Once the development is complete, the ground tenant sublets space to retail, office or industrial tenants depending on the type of development. Ground leasehold interests may be bought and sold in a manner similar to fee simple property interests. b. Commercial, industrial and retail leasing Most commercial office and retail space and much of the standard industrial space in Canada is available only through a commercial lease. Most commercial lease transactions start with an offer or agreement to lease. Unlike the U.S., an offer or agreement to lease is typically a binding agreement that contains the business terms agreed upon by the parties, including the space, term, rent and any tenant inducements. Most commercial leases in Canada are typically on a net/net rental basis, which requires a tenant to pay, in addition to basic rent, a proportionate share of the realty taxes, insurance, utilities and other maintenance charges for the commercial building. In a retail lease, a tenant may also be required to pay rent based on a percentage of its annual gross sales. c. Residential leasing Residential leases are regulated by provincial legislation. In some cases, the applicable provincial legislation will override the terms of the lease agreement, regardless of the intention of the parties, and in some provinces even the ability of the landlord to increase residential rent is limited by provincial regulation. 8. Financing a. Sources of financing Most real estate financing is arranged through institutional lenders such as banks, credit unions, caisses populaires, insurance companies, trust companies and pension funds. However, there are also
6 6 doing business in Canada a number of non-institutional and private lenders that lend money in the Canadian financial market. As is the case in other countries, credit terms will vary from lender to lender and will depend on the nature of the transaction and the risks involved. The Canadian banking system is widely considered the most efficient and safest in the world, ranking as the world s soundest banking system for the past three years according to reports by the World Economic Forum. The banking and lending industry in Canada is highly regulated. There are a number of federal statutes that govern the banking and lending industry, such as the Bank Act, Trust and Loan Companies Act, Credit Unions and Caisses Populaires Act, 1994, and the Insurance Companies Act. Canada s high degree of regulation in its banking systems has been lauded in the most recent debt crisis. b. Interest rates Interest rates on real estate financings can be either fixed for a specified period of time or variable, based on a prime rate set by the lending institution on a periodic basis. The prime rate is based on a rate announced by the Bank of Canada from time to time. A borrower may consider borrowing in other currencies and has a choice of interest rate pricing, including applicable Government of Canada Bond Rates, the London Interbank Offered Rate (LIBOR) and bankers acceptances. Certain fees, such as commitment and processing fees, are normally charged by lenders. Typically, it will be the borrower s responsibility to pay for all of the lender s legal and other costs in arranging property financing. The Interest Act of Canada dictates, among other things, how interest rates are to be presented to the public to ensure fairness and transparency. c. Primary and collateral security Lenders, whether they are financial institutions or thirdparty arm s-length lenders, usually take both primary and collateral security in real property and related assets to secure the loan. Typical primary security includes a mortgage or charge, a debenture containing a fixed charge on real property or, in some cases where more than one lender is involved, a trust deed securing mortgage bonds or debentures, and including a specific charge over real property. Collateral security often includes general and/or specific assignments of leases and rents, general security agreements, assignments of contracts and insurance policies, and personal guarantees. d. Foreign lenders Because many foreign lenders in Canada are subsidiaries of the world s major banks, they typically participate by way of syndicated loans, which are often arranged by major Canadian lending institutions. However, there are also Canadian lenders who participate in syndicate lending as well. There has been a lot more syndicate lending since the real estate dip in the early 1990s. Whether through a syndicate or directly, foreign lenders may be subject to certain withholding and other forms of taxes on the interest paid to them, and it is advisable to seek the advice of a tax lawyer. 9. Environmental concerns Canada is quite sophisticated and advanced in terms of its environmental legislation, due to the abundance of its natural resources. All levels of government have enacted detailed statutes, laws, regulations, bylaws, guidelines and recommendations concerning the protection of the environment. These laws attribute liability for environmental damage to the owner of land and to polluters of the environment. Tenants often make the mistake of assuming that, since they do not own a property, they are not liable, but in some provinces and jurisdictions, merely being in occupation, management or control of real property may attribute liability. A property owner has certain duties and obligations relating to the discharge of contaminants and hazardous materials into the environment from its property. Note that liabilities associated with improper waste management practices can be inherited by subsequent owners of a property. 10. Environmental risk assessment A purchaser should assess the environmental risks associated with a property being purchased. In Canada, government officials do not certify that a property is free from such risks. A property s environmental status can be ascertained by inspecting applicable company
7 doing business in Canada 7 and public records. In many cases, a purchaser will want to do an environmental audit of the property, which may include conducting scientific testing and a technical analysis of the property. Lending institutions often require such an audit before advancing any funds. The conducting, delivery and review of environmental audits can be a complex area. One is advised to ensure that the consultants retained to do the environmental investigations are approved by the recipient of the report, such as a lender or municipality otherwise the investigation may not be acceptable and will have to be conducted again. 11. Development controls Property development is provincially regulated, primarily at the municipal level. Municipalities typically control land use and the density of development through official plans and zoning bylaws. Many municipalities impose development charges on new developments within their jurisdictions. Certain provinces restrict and regulate the ability of an owner to subdivide property. The construction of new projects is also subject to provincial and municipal legislation. In addition to regulating the maintenance of existing structures, building codes set specific standards for the construction of buildings. Before construction commences, most municipalities require building permits, payment of any applicable fees and that all regulatory approvals be obtained by the property developer. 12. Real estate broker and mortgage broker legislation Generally, a person who wishes to dispose of or acquire real estate will seek the assistance of a real estate broker. Real estate brokers are subject to specific regulations in Canada. Each province has legislation that regulates the trade in real estate, which is designed to better protect consumers and instil confidence in the buying and selling of real estate. Provinces have various types of governing bodies that regulate the purchase and sale of real estate, the conduct of real estate agents, and the minimum standards for duty of care to the public when engaged in the purchase and sale of real estate. As with real estate brokers, mortgage brokers, lenders and administrators are subject to specific regulations in Canada. These regulations are governed by various pieces of provincial legislation. In Ontario, the Mortgage Brokerages, Lenders and Administrators Act, 2006 went into full effect in The Act requires all mortgage brokerages, administrators, brokers and agents to obtain a licence to do business in Ontario. Similar legislation either exists or is under consideration in most of the other provinces. Learn more about Gowlings services in this area at gowlings.com/realestate